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It's always been a puzzle to me why stocks prices can continue to surge as the economic statistics get worse; a depression in Spain with 25% unemployment, housing prices dropping for the 6th straight month, GDP down to 2.2%, stores closing all over New York.

Perhaps a paper given at the Federal Reserve Bank of Boston on April 22 by two Harvard economists, and one from the New York Fed-- "Investment Dynamics With Natural Expectations" gives a partial explanation.

" We study an economy in which agents have the wrong beliefs about the dynamic properties of fundamentals," write Harvard's Benjamin Herbert and David Laibson( who will b e on my panel at my 55th Harvard reunion on May 22) and Andreas Fuster of the New York Fed.

" The premise of our approach is that economic agents tend to make forecasts on statistical models or mental representations that tend to underestimate the degree of long-run reversion in fundamentals."

Stated in language Aunt Sadie could understand it means that stock prices rising today based on optimistic expectations in the future about profits and growth is a short-sighted view with an overly positive and optimistic bias that doesn't weigh properly a host of other potential scenarios.

Summed up, this instructive paper makes you understand how Wall Street pros and amateur tv cable pundits can use their wishful thinking about animal spirits(they can turn down on a dime), what look like amplified business cycles and excess volatility become biased in their view of the boom continuing.

The reason; they are using too small statistical samples. They are employing models with only a small number of variables. So, "agents(what a great tag for investors) underestimate the degree of mean reversion." Mean reversion is t he dynamic which should inform you that if the market is up 12% or 16% or 20%, it's likely to return to the historical mean gain sooner or later.

Behavioral economics, which I know is Laibson's specialty, seems to suggest that impulses can louse up rational expectations. Boy, did we ever learn that in 2007-2008 when hubris, , excessive optimism, the recklessness of using dangerously stupid levels of debt without proper rational risk controls caused losses of so many trillions that may never be wholly gained back.

Wall Street, benefitting from the Fed's historic cheap money policy, wants asset prices( read stocks) to keep rising so as to stimulate economic growth. They want it so much they don't see economic repression-- deleveraging, deflation and demographic problems ruining the party sooner or later.